If you’re planning to buy a home soon, shopping around to find the perfect place is the fun part. But before you begin contacting real estate agents to assist with your search, there’s an important step to take. You’ll need to get pre-approved for a mortgage to set a home shopping budget. Read on to learn more about what it means to be pre-approved, how it differs from pre-qualification and how to get started when you’re ready to buy your first or next home.
Is Mortgage Pre Approval the Same as Pre Qualification?
The terms mortgage pre-approval and pre-qualification are often used interchangeably. However, they aren’t quite the same, as one holds more weight than the other.
When you reach out to the lender to get pre-qualified, they will review the financial and income data you share to determine if you could be a good fit for a loan and provide you with potential loan amounts, interest rates and monthly payments. However, they won’t do a hard credit check – a soft pull may be done, though.
A pre-approval is a bit more involved, though. You’ll need to provide financial information and income documentation. The lender will also check your credit to ensure they account for all the outstanding debt you have. Doing so allows the lender to generate a more concrete home loan quote that includes your spending budget or the maximum purchase price of a home and an estimated monthly mortgage payment amount based on the interest rate and loan term you receive. Keep in mind that the interest rate you’re quoted can quickly change as market conditions sometimes cause daily fluctuations.
Many mortgage lenders also provide an estimate of the cash you’ll need to close the loan. On average, homebuyers pay between two percent and six percent of the home loan amount for closing costs, depending on their location. So, if you take out a home loan for $385,000, closing costs are typically between $7,700 and $23,100.
Why Should You Get Your Mortgage Pre-Approved?
Getting pre-approved for a mortgage lets you know how much home you can afford. It also tells you the maximum amount the lender is willing to let you borrow so you can shop with confidence.
Another significant advantage of getting pre-approved is the buyer power it provides. Sellers will take you more seriously because they know you’re serious about purchasing a home and not just casually browsing to see what’s available. Furthermore, you’ll have the ability to make stronger offers than if you weren’t pre-approved.
How Far in Advance Should You Get a Mortgage Pre-Approved?
Ideally, you want to get pre-approved for a mortgage prior to shopping for a home. Otherwise, you risk missing out on a great opportunity if you need to make an offer but don’t have the pre-approval letter from the lender handy.
Keep in mind that while some lenders can get you pre-approved in as little as one business day, others take a little longer. So, the earlier you get the ball rolling, the better. Once you’re pre-approved, the letter will be valid for between 60 and 90 days, depending on the lender.
What Factors Affect If You Get Pre-Approved for a Mortgage?
When determining if you’re a good fit for a mortgage, lenders will usually consider these factors:
- Monthly Income: Do you earn enough to comfortably make mortgage payments?
- Employment: Have you been employed in the same industry for at least two years? (Some lenders will accept one year of steady employment)
- Credit score: Is your middle credit score at or above the acceptable figure for the loan program you’re considering?
- Debt-to-income (DTI) ratio: Is the total amount of your minimum monthly debt payments at or below 40 percent of your gross income?
This list may not be all-inclusive, as some lenders may look at other factors. Inquire before applying for pre-approval to learn more about their specific guidelines or overlays that could make it more challenging to qualify for a home loan.
5 Steps on How to Get Pre-Approved for a Mortgage
If you’re ready to get pre-approved for a mortgage, follow these steps to make the pre-approval process more seamless.
1. Prepare All Necessary Documents
It helps to gather all the personal information and financial documentation the lender will need before submitting the application to avoid processing delays. This includes:
- A copy of your driver’s license or state-issued identification card
- Your Social Security number
- Your employer’s name, address and contact information for your supervisor
- Proof of assets, including bank statements and investment account statements
- Proof of employment, including most recent tax returns, pay stubs and W-2 statements
2. Assess Your Credit Score and your Finances
Get copies of your credit reports from the three major credit bureaus – Experian, TransUnion and Equifax. Then, review the contents and file disputes to have any inaccuracies rectified before applying. Otherwise, information that could be dragging your credit score down will be present for the lender to see.
Also, take a look at your credit scores from the credit reporting agencies. Lenders will use the middle number on your loan application. So, if your three scores are 695, 705 and 681, 695 is what will be used.
3. Determine Your Monthly Payment
Review your spending plan to determine how much mortgage payment you can afford. The lender may approve you for a home loan with a much higher number, but only you know what makes sense for your finances. And it’s vital that you stick with this figure, which includes interest, mortgage insurance, property taxes, insurance, and any other escrow payments to protect your financial health.
4. Time Your Application
Another important consideration to keep in mind is that several mortgage inquiries in a set period – usually 45 days, will only impact your credit score once. So, don’t be afraid to shop around within that timeframe to find the best deal. But only do so when you’re serious about buying a home.
5. Choose the Right Lender
Now that you’ve done all the legwork to prepare for the mortgage process, it’s time to get pre-approved. Most lenders allow you to complete the process online from the comfort of your home without taking up too much of your time. You have the option to get pre-approved in person if the financial institution you’re considering has brick-and-mortar locations, but the process could take a bit longer than it would if you got started online.
Frequently Asked Questions (FAQs)
The amount of time it takes to get pre-approved for a mortgage depends on how you apply. Getting started online is usually the fastest way to hear back from the lender. This option is available with lenders offering digital uploads and pre-approvals, and you can hear back in minutes. But if this isn’t an option, you can submit an online form, upload the requested documentation and receive a response from the lender following their review – sometimes as soon as one business day.
If you choose to get pre-approved in person at a physical location, the timeline will depend on whether you visit when a loan officer is on site. It’s best to make an appointment beforehand to avoid playing the waiting game or making a blank trip only to have to come back later another day. Once your application is submitted, it could take a few days or a week to hear back. The loan officer may also request another meeting to address any questions or concerns they may have before making a pre-approval decision.
Each time you apply for credit, your credit score drops by two to five points. In addition, hard credit inquiries linger on your credit report for up to 24 months, though they typically only impact your credit rating for a few months. So, when you get pre-approved for a mortgage, expect a slight dip in your credit score. But, depending on your credit rating, it may not make much of a difference in the interest rate you’ll be quoted on a home loan product. But keep in mind that the most competitive terms are generally reserved for borrowers with good or excellent credit scores.
When you’re on the quest for the perfect home loan, it’s always ideal to shop around to find the best deal. However, applying with several lenders does mean multiple hard pulls or hard credit inquiries that could lower your credit score. The upside is the FICO-scoring model allows consumers to rate shop for 30 to 45 days to find the perfect mortgage. That said, several home loan applications submitted in this window only count as a single hard credit inquiry, minimizing the impact on your credit score.
Unfortunately, it’s possible to get pre-approved for a home loan and still be turned away by the lender prior to closing. This often occurs if there are significant changes to the borrower’s credit rating, employment situation and financial status.
To dive a bit deeper, each home loan product comes with a preset minimum credit score requirement. Some lenders take things a step further by adding overlays or more stringent eligibility criteria that could make getting approved more challenging. If your credit score is high enough to get pre-approved but drops below the lender’s minimum threshold before closing, you may be denied financing.
The same rule applies to the debt-to-income (DTI) ratio lenders use to determine how much home you can afford. If you acquire a hefty sum of debt between the time that you’re pre-approved for a home loan and are set to close, the added debt payments may cause your DTI to rise above the lender’s maximum allowable limit.
A change in your employment situation can also trigger a denial. For example, if you take a demotion resulting in a pay cut, accept a position with a different employment in another industry or start your own business, your mortgage pre-approval could be impacted. So, if you foresee a career change, it’s worth consulting with the mortgage lender first to determine what can be done to make it to the closing table.
Assess your spending habits and budget to determine if your household income is sufficient to cover a monthly mortgage payment and other related housing expenses. If so, check your credit score to see where you stand, and review your credit report in its entirety to ensure it’s free of errors that could be dragging your score down and that need to be rectified. You should also compute your DTI ratio to determine if it meets the lender’s standards.
You may find that it’s too high, and some of the outstanding balances need to be reduced or eliminated to qualify for a mortgage. However, a lower DTI also means your monthly mortgage payment will be more manageable as you’ll have a small debt load to worry about. Plus, paying down revolving debt before applying for a home loan will reduce your debt utilization rate and possibly boost your credit score.
